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Saturday, 21 March 2015

I am Successful Because I am Capable? Do not be Fooled by Randomness!

You had just earned
your first pot of gold…several hundred thousands, millions or more. A
multi-bagger returns from your investments; a lucrative business ventures. Or a
promotion to be the MD or better CEO; a biggest pay raise you can ever
imagine...so on and so forth.

You are happy and over
the moon. Of course Fools will be arrogant! You attributed the “success” to you
being the smartest, most capable and possibly is hardwork paid off.

In other words, you
think you are the smartest and invincible?

Now, someone by the
name of Nassim Taleb is there to argue with you. He will probably tell you
straight in your face…

“Do not
be Fooled by Randomness. There is something called Dumb Luck!”

Fooled by Randomness – The Hidden Role of Chance in the
Markets and in Life

Fooled by Randomness,
is a thought provoking and one of the smartest books around. I finished reading
the book last month. The reading was done almost entirely throughout air plane
journeys I had last month. The book was recommended to me by fellow blogger LP.

To begin the idea of
randomness, I will recall a short story written in the book.

Consider two
neighbours, John Doe A, a janitor who won the New Jersey lottery and moved to a
wealthy neighbourhood, compared to John Doe B, his next-door neighbour of more
modest condition who has been drilling teeth eight hours a day over the past 35
years – A Dentist.

Clearly one can say
that, thanks to the dullness of his career, if John Doe B had to relive his
life a few thousand times since graduation from dental school, the range of
possible outcomes would be rather narrow (assuming he is properly insured).

At the best, he would
end up drilling the rich teeth of the New York Park Avenue residents, while the
worst would show him drilling those of some semi-deserted town full of trailers
in the Catskills.

As to John Doe A, if he
had to relive his life a million times, almost all of them would see him
performing janitorial activities (and spending endless dollars on fruitless
lottery tickets), and one in a million would see him winning the New Jersey
lottery.

Provoking Thoughts by the Author

Below I will share some
interesting thoughts / excerpts in the book

Randomness

Humans are often
unaware of existence of randomness.

Do not look too much
for explanation for events. It can just be random.

Small Success & Big
Failures

Even if you win 99
times out of 100, there is no certainty that you are successful. Your one
failure can be so big and disastrous that it bankrupt you.

"Option
sellers, it is said, eat like chickens and go to the bathroom like
elephants", which is to say, option sellers may earn a steady small income
from selling the options, but when a disaster happens they lose a fortune.

There are routes to success that are
non-random. Those who go the extra mile are rewarded. In my profession one may
own a security that benefits from lower market prices, but may not react at all
until some critical point. Most people give up before the rewards.

Time Eliminates
Randomness

Nassim believes that success can be attributed to luck
because of a lucky sample path or a rare event. Only over long time we can see
true capabilities. Time aggregation eliminates effects of randomness.

Risk

Manage risk and avoid
blow up. Blow up is describe as not just to lose money; but to lose more money
than one ever expected, to the point of being thrown out of the business

Stop loss, a predetermined exit point, a protection
against the black swan. It seems like it is rarely practiced.

Nassim described Nero as a trader who is very risk averse.

“Nero rapidly exits
trades after a predetermined loss. He
never puts himself in a situation where he can lose more than, say, $1,000,000
- regardless of the probability of such an event. That amount has always
been variable; it depends on his accumulated profits for the year.

Nero's temperament is
such that he does not mind losing small money. "I love taking small
losses", he says. "I just need my winners to be large". In no
circumstances does he want to be exposed to those rare events, like panics and
sudden crashes that wipe a trader out in a flash. To the contrary, he wants to
benefit from them.

Why doesn't Nero make more money? Because of
his trading style - or perhaps his personality. Nero's objective is not to
maximize his profits, so much as it is to avoid having this entertaining money
machine called trading taken away from him. Blowing up would mean returning to
the tedium of the university or the non-trading life.

Every time his risks increase, he conjures up
the image of the quiet hallway at the university, the long mornings at his desk
spent in revising a paper, kept awake by bad coffee. No, he does not want to
have to face the solemn university library where he was bored to tears. "I
am shooting for longevity", he is wont to say.”

History & Probability - Irrelevant

Historical event and frequency of probability is totally
irrelevant for event of success. It needs to be judged in connection with the
magnitude of outcome. E.g. Event A: 999/1000 chance of winning $1 and Event B: 1/1000
chance of losing $10k. Will you bet?

Odds are that we would make money by betting for event A, but
it is not a good idea to do so.

Media
& Journalist - Useless

Nassim
thinks that reading newspaper is a complete waste of time, because journalists
are being paid to provide explanations, and will gladly and readily provide
them accordingly. He said:

“On the rare occasions when I boarded the 6:42 train to New York
I observed with amazement the hordes of depressed business commuters (who
seemed to have preferred to be elsewhere) studiously buried in the Wall Street
Journal, apprised of the minutiae of companies that, at the time of writing,
are probably out of business. Indeed it is difficult to ascertain whether they
seem depressed because they are reading the newspaper, or if depressive people
tend to read the newspaper, or if people who are living outside their genetic
habitat both read the newspaper and look sleepy and depressed.”

Emotions
in Investment - Detrimental

“When I see an investor monitoring his
portfolio with live prices on his cellular telephone or his PalmPilot, I smile
and smile.”

Studies
have shown that we feel the effects of negative emotions 2.25 times stronger
than we feel the effects of positive emotions. Therefore if we view an
investment portfolio every minute of the day, the mere randomness factor of the
markets will cause us to feel more pain than positive emotions, even if our
portfolio has increased in value.

Wealth - Do Not Compare

When there are too many millionaires next door, you are often
a failure, a very successful but comparative failure. Therefore move away from
your house / neighbourhood.

“We should remember that becoming rich is
purely a selfish act and not a social act. I am not impressed by people with
money. Becoming rich is not directly a moral achievement… ”

On Jim
Rogers

“Even some experienced trading veterans do not seem to get the
point that frequencies do not matter. Jim Rogers, a "legendary"
investor, made the following statement:

I don't buy options. Buying options is another way to go to the
poorhouse. Someone did a study for the SEC and discovered that 90 percent of
all options expire as losses. Well, I figured out that if 90 percent of all
long option positions lost money, that meant that 90 percent of all short
option positions make money. If I want to use options to be bearish, I sell
calls.

Visibly,
the statistic that 90% of all option positions lost money is meaningless,
(i.e., the frequency) if we do not take into account how much money is made on
average during the remaining 10%. If we make 50 times our bet on average when
the option is in the money, then I can safely make the statement that buying
options is another way to go to the palazzo rather than the poorhouse.”

On George
Soros

Nassim
mentioned that instead Rogers’ partner, George Soros knew how to handle randomness, by keeping a critical open mind and
changing his opinions with minimal shame. (which carries the side effect making
him treat people like napkins)

Rolf’s Thoughts

Clearly, I am amazed by
how one topic of “Randomness” can lead to an Author write a whole book.

I am actually further humbled
after finished reading the book. I very much agreed that a random event of luck
is critical to being successful, i.e. if success is very much related to
wealth. And the time factor is not a critical consideration.

Nonetheless, I also
believed that success over a sustained long period of time, by itself cannot
only be attributed to luck or randomness.

No matter what, I
always remind myself as follows.

“In times
when we are doing great, do not be too arrogant and over the moon. It can be
that we have not experience the worst, or the success is entirely through
randomness, which may not last.

On the
contrary, when we are NOT doing well due to random events, do not be devastated
and give up. Our time of success will come eventually, that is, if we persist,
continue to improve ourselves, have good attitude, positive mindset..etc.”

13 comments:

Hold on to that idea and go on to read black swan. The picture becomes clearer and the idea gets crystallized when you finish the trilogy (fooled by randomness, black swan, antifragile ...in that order). If you still have time, throw in bed of procrustes.

Don't worry! Some books take more than 1 reading to appreciate, and it's often these books that we come back again again to revisit the ideas. The book might not have changed, but we will grow and interpret the same words different based on what we had experienced in life.

Just get a brief over view of the big picture. You don't have to understand every line in order to see the bigger picture. Black Swan should get better to read than this ;)

Thanks for introducing this book. I'm going to make that my next read. It reminds me of the book "freakonomics", was it really luck that a drop out like Bill Gates founded Microsoft and why is that Students born earlier in the year always seem to do better than those born near the end of the year.

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This blog and its contents contain the opinions and views of me. It is not a recommendation to purchase or sell the stocks of any of the companies or investments herein discussed. If a reader requires expert financial advice, a competent professional should be consulted. I cannot guarantee the accuracy of the information contained herein the blog and its contents. Other than being the shareholders of some of the stocks discussed herein at the time of writing, I am not in any way related to the company mentioned within the blog. I specifically disclaim any responsibility for any liability, loss, or risk, professional or otherwise, which is incurred as a consequence, directly or indirectly, of the use and application of any contents of this blog.